High Yields Are the New Norm for Israelis. But Is This Real Growth?

The real engine behind the incredible returns Israelis have been enjoying is the U.S. stock market. Double-digit returns have become the standard – but for how long and at what cost to the economy and society?

Guy Rolnik
Guy Rolnik
Traders on the floor of the New York Stock Exchange (NYSE) on the first day of trading this year
Traders on the floor of the New York Stock Exchange (NYSE) on the first day of trading this yearCredit: SPENCER PLATT - AFP
Guy Rolnik
Guy Rolnik

Hundreds of thousands of Israelis reacted with great indifference to the report published last month about the performances of their advanced study funds (“keren hishtalmut”), pension funds, provident funds and managers’ insurance (“bituach minahalim”).

October ended with a return of 2 to 3 percent in the so-called “general” track (medium-risk, moderate exposure to the stock market) and while November yields were down, the average return from the beginning of the year was just over 12 percent.

Investors who tend to take bigger risks, mainly the wealthy, saw their investment portfolios grow by 20 percent this year. Another ordinary year on the stock market – nothing to report.

The main reason for Israelis’ indifference to these returns is the fact that for the past decade, with the exception of short interludes, the annual yields in Israel’s most popular and common investment tools have been fluctuating around a two-digit level. We have become accustomed to thinking that the stock market is doing what a stock market is supposed to do – increase by 10 percent annually.

Those who are having trouble understanding what’s happening with their pension and in the markets in recent years are those who have been tracking them for more than a decade. Because until recently there was a name for people who promised investors an annual yield of 10 percent year after year: Bernie Madoff. Only con men can create a two-digit return every year – until it implodes.

For decades it was generally thought that anyone who wants a two-digit return over the long term must take big risks. But we’ve been living for a long time already in a strange period: The markets are continuing to rise, and nobody feels that he’s taking exceptional risks. High profits on investments, even those that are presumably solid, have become the new normal.

So perhaps opposition leader Benjamin Netanyahu is right? Is Israel an economic paradise that only leftists and other sourpusses don’t acknowledge? Perhaps in an era of economic prosperity, Netanyahu’s decade, it’s only natural for the stock market to rise and with it the investments of masses of Israelis, and not only those who have stock portfolios, but every small saver who has a pension fund, managers’ insurance, a provident fund or an advanced study fund. After all, we’re talking about 10 percent a year even in the average and most conservative advanced study fund.

That’s a good story that some of our readers would be happy to buy, but it’s not accurate. Israel’s economic growth played a part in this financial growth, but not a particularly large part.

Most readers of this column will be surprised to discover that about half, and sometimes more, of the stocks component in their investment portfolio isn’t even Israeli stocks. In the past 20 years, the major investment managers – insurance, pensions, provident funds and advanced study funds – tripled the component of foreign stocks in the public’s investment portfolios. As of now, about 12.5 percent of Israelis’ financial assets, about 600 billion shekels ($192 billion), is invested in foreign stocks, mainly in the U.S. stock market.

In effect, the sharp increase in the value of foreign stocks would have been even greater were it not for the collapse of the dollar versus the shekel in the past year – the percentage of large investment portfolios comprised by foreign stocks would have already passed the percentage invested in local stocks (14.8 percent).

Foreign stocks made an exceptional contribution to our pension portfolios, because the performance of the Israeli stock market pales in comparison to that of the U.S. stock market: The S&P500 index rose by 310 percent in the past decade and Nasdaq soared 550 percent, compared to the Tel Aviv Stock Exchange’s TA-125 (formerly the TA-100), which returned only 100 percent.

The huge profits in the U.S. stock markets in recent decades don’t particularly concern Israelis in general or decision makers in particular. But perhaps we actually should take an interest in what’s happening with them. Why? The first reason is simple: Should U.S. stock markets change direction, it will have a tremendous effect on hundreds of millions of shekels of public money, far beyond what most Israelis are aware of, due to the decision by Israeli investment managers to substantially increase the component of foreign stocks in investment portfolios. The second reason is just as important – and that’s the real engine behind the amazing returns in the U.S. stock markets.

The source of wealth

Most of the public tends to believe that there is a connection between stock market performance and economic growth, that the stock market is a kind of barometer of the general situation. Of course in the short term there are fluctuations and it’s hard to identify the correlation between stocks and the economy, but over the longer term everyone believes that the behavior of stocks is based on corporate revenues and profits, which are ultimately linked to the country’s real economic growth.

In fact there is a stark difference between the reality of the stock market and the common perception of it. Many of those who determine economic policy in Israel and worldwide have not realized – or don’t want to realize – that the connection between asset prices and economic growth was severed a long time ago.

A recent study by three economists from MIT, the University of California, Berkeley and New York University tried to identify the engines behind the tremendous increase in U.S. stock prices in the past four decades. The results are quite astonishing.

Between 1989 and 2017 stock markets in the United States added $34 trillion in “wealth.” That is an astonishing return – in those two decades the return in U.S. markets was three times as high as that of the three previous decades, between 1951 and 1988.

Did the U.S. economy grow in those decades at a rate triple that of the 1950s to the 1980s? Is it innovation? The computerization revolution? Productivity? Efficiency? Social media? Smartphones?

Not really. After dismantling the “engines” behind the creation of this wealth, which is the greatest creation of wealth in the history of mankind, the researchers reached conclusions that are substantially different from what most of us tend to take for granted.

The source of 44 percent of this additional wealth is the transfer of assets from a series of interested parties into the hands of the most successful group in the United States in our times: the shareholders. And of course, when we say shareholders, we have to recall that most of the stocks are held by the top decile, with the top 0.1 percent increasing its share most rapidly.

Who are the interested parties from whom wealth was transferred to shareholders? Mainly workers and taxpayers. And what about economic growth, the engine that is supposed to create most of the “wealth” in modern society over the long term? It was responsible in those years for only 25 percent of the increase in the stock markets. Another 18 percent stemmed from a decline in the risk of the stocks and 14 percent from a drop in interest rates.

The findings of this study can be combined with other studies published in the United States in the past decade, which demonstrate that in recent decades there was actually a decline in productivity and innovation compared to previous historical periods. Many economists have long ago admitted that the huge contribution to productivity that could presumably be attributed to the computerization and communications revolution can be found everywhere except in the economic data.

Surprise, surprise, surprise: It turns out that the contribution of inventions such as steam, electricity, the radio and even the washing machine in the late 19th and early 20th century was far greater than the contribution of the wave of innovation in recent decades, such as the apps on which you can spend 24 hours a day looking at pictures of your friends having fun. And of course, all these figures come against the backdrop of studies into inequality in the United States: For decades the median salary has remained stagnant, at a time when most of the fruits of growth reach the top 10 percent, 1 percent and 0.1 percent.

In my opinion, these three trends actually tell the same story. The U.S. economy has been managed for the past several decades around a single organizing principle: maximizing the value of assets, mainly stocks and real estate. In the past two years this system has reached an extreme: The global economy was disrupted for over a year, production collapsed, millions lost their jobs, but the stock markets in the United States accelerated even faster, while the printing of money by the Federal Reserve Bank added fuel to the fire.

According to the Federal Reserve Bank, the top percentile in the United States now has greater financial wealth than the entire middle class, which accounts for 60 percent of the population.

The wave of share price increases on Wall Street in the past year was so fast and strong that its ripples reached anyone with an Israeli advanced education fund, provident fund or pension, which this year saw returns of over 10 percent and a cumulative return in the past decade of 50 to 100 percent, depending on the risk profile.

There are several characteristics common to an economy organized around maximizing wealth for shareholders: a diminishing share of revenues going to workers; an increasing share of economic activity outsourced to countries with cheap manpower; a decreasing share of real investments; a transition to investment in software and services; investment of an increasing share of the profits in purchasing stock, in order to inflate the directors’ options packages; and of course aggressive tax planning, mainly by multinational companies.

Every year the wealth created by these methods is concentrated in fewer and fewer firms; the markets in the United States are becoming more centralized, and a handful of giant software companies are turning into de facto monopolies. The huge value that they create for their shareholders no longer relies on their innovation, but mainly on a winner-take-all economy.

If we compare the financial wealth created in the past decade in Silicon Valley to the formative decades in the 1960s and 1970s when it flourished, we will discover that the wealth created in the past decade is seven times as great as any value created in the years when all the pioneering technologies, on which most of the technology giants are based to this day, were invented. In other words, the tremendous wealth created in recent decades, tens of trillions of dollars, stems mainly from economic and financial engineering rather than a great increase in growth, quality of life or even innovation.

The American model has not been universally adopted: The proof is that the performances of the New York Stock Exchange on Wall Street overshadow those of most of the world’s stock markets. In China, for example, the model is the opposite: They organize the economy so that it will create growth and real investment rather than stock price increases.

In the West we tend to interpret every Chinese action against the giant corporations as nothing more than a political move by an authoritarian regime that wants to eliminate competing power centers, but the dictators in China know something more: In order to continue to rule, they have to create genuine growth rather than growth that is concentrated in stock prices, as in the United States. Although the U.S. is a “democracy,” its political power is concentrated mainly in the hands of the wealthiest.

In Israel we haven’t fully adopted the American model, but a growing number of forces here would be happy to see us following in its wake. The strongest and most dominant sector in Israel today is high-tech, which is the principal beneficiary of the American model. The large number of Israeli unicorns – there are more than 60 such startups worth at least $1 billion – and their unprecedented prices – the past year a string of companies exceeded the $10 billion mark – aren’t the result of an unprecedented burst of innovation in Israel, as the media tries to convince us every morning, but a direct result of the prices of U.S. high-tech stocks.

And the United States is a country whose politicians, as mentioned, have decided to structure the economy around maximizing stock prices. A country in which much of the public services – health, education, transportation, infrastructure and housing – suffer from neglect, but a large percentage of the elites are indifferent or blind to that fact, since their tremendous wealth enables them to purchase most of those services privately.

The shares of hundreds of large, medium-sized and small high-tech companies on Wall Street soared in recent years to prices that are 10 or 20 times beyond their sales, and to profit multiples of 50, 60 and sometimes 100. There are also many companies that are showing losses, but that are traded for billions of dollars based on growth forecasts. The prices of these hundreds of companies are pushing up the prices of startups, and talented Israeli entrepreneurs are hastening to exploit the opportunity.

Economists and journalists observeing stock prices rising over the long term usually tend to assert that this is a “bubble,” and to recall previous incidents in which the general public or the banks inflated shares due to a mass mania that drives people to believe that it’s possible to get rich without working.

Ringing the TASE opening bell at the opening ceremony of the Emirati embassy in Tel Aviv in July.Credit: Amir Cohen/Reuters

But the present “bubble” in the stock markets in general and in high-tech in particular is far more profound than previous bubbles. That’s because it is being organized by governments, fueled by central banks and maintained by politicians, who know that the road to reelection is by promising to maintain high asset prices for the economic elites that support them.

Of course the bubble of “government policy that supports asset prices” is being joined by a potential “ordinary” bubble of investors who are convinced that stock prices can only rise, and consequently increase the risk component in their portfolios. The millions of new customers of stock market trading apps such as Robin Hood, whose average age is 31, have never seen a falling stock market, and are convinced that they have found the way to get rich without working.

But the foundations of the unprecedented rise in asset prices in the United States, and to some extent in Israel, which is affected by Wall Street, are not an ordinary “bubble,” but the economic policy of the U.S. administration, which sees the value of assets as a supreme economic goal.

For years data about the growing disparity in wealth and property between the top percentile and the rest of the public have been published on a monthly basis. That’s why the rate of support by the American public for taxing billionaires is now the highest ever. In Israel, on the other hand, the Finance Ministry, the Bank of Israel and the Tax Authority don’t want to study these figures and don’t want to publish them. We can understand why: Such figures are likely to point to a dramatic widening of the gaps, and could disturb many Israelis.

But there is no reason to think that in the past two years there hasn’t been a sharp increase in the gap between a small group of holders of assets – shares and real estate – and the other 90 or 99 percent of the public. And the question that is not being asked here, not in the Knesset, not in government ministries, not in the research institutes and certainly not in the media, is how Israel wants to structure its economy: around maximizing the wealth of asset owners or around improving the quality of life, the standard of living and primarily, public services to citizens.

A small stratum of Israelis is now benefiting greatly from the U.S. decision to structure its economy around the stock market, but it is doubtful whether this system is sustainable, and even more doubtful whether it is appropriate for Israel.

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